IBBI’s cost tweak: The case for and against

Insolvency process costs include any cost—such as for electricity and water—incurred by a RP in running a bankrupt business. IBBI amended its regulations on 15 February to say that the RP shall seek the committee of creditors’ (CoC) clearance for all such costs, at each meeting.

While some experts said the requirement was impractical, others said taking advance approvals from the CoC—comprising financial creditors like banks—could ensure that the costs needed to preserve a company as a ‘going concern’ do not exceed the money that the lenders may get at the end of the resolution process. In turn, this would also help in avoiding litigation.

“Requiring CoC to approve all operational costs for them to be considered as insolvency resolution process costs, which the resolution professional is otherwise mandated to incur under the IBC to maintain the company as a going concern, is impractical and it militates against preserving the distressed entity as an active business," said Anoop Rawat, partner (insolvency and bankruptcy) at law firm Shardul Amarchand Mangaldas & Co.

On the other hand, Mukesh Chand, senior counsel at law firm Economic Laws Practice (ELP), said that the new regulation would help avoid situations where operational costs become so high that the resolution corpus shrinks to the detriment of the lenders, pointing to such an instance of running a power plant that had gone bankrupt.

Chand explained that IBC mandates various process costs, including interim finance, RPs’ fees, and operational cost requiring CoC approval. Regulation 34 of the Corporate Insolvency Resolution Process (CIRP) regulations already requires the CoC to approve expenses incurred by the RP, including those related to running the corporate debtor.

“Although an additional step, now explicitly outlined in regulations, it signifies a crucial shift towards pre-approval, aimed at averting scenarios where exorbitant operational expenses devouring the resolution corpus, leaving little for stakeholders. This proactive approach not only empowers resolution professionals to pre-empt extreme situations but also instils confidence in CoC's oversight, fostering robust checks and balances essential for distressed firms," said Chand.

Some experts have pointed out that it is the duty of the RP under the Insolvency and Bankruptcy Code (IBC) to preserve the value and manage the operations of the distressed business as a going concern. IBC says the RP has to make ‘every endeavour’ in that direction.

Also, it is the RP’s duty to preserve the assets of the entity, including its ‘continued business operation’ and so the tweak in regulations to mandate prior CoC approval for the debt resolution process costs goes beyond what the Code says. Lenders tend to keep the process costs low in order to optimise the eventual proceeds they may realise from debt resolution. This puts them at loggerheads with operational creditors like vendors and suppliers of the bankrupt business.

“It is not clear how a situation would be treated where the resolution professional considers a cost necessary for maintaining corporate debtor as a going concern, but the CoC refuses to incur it," said Rawat. Uncertainty about payments will also create doubts in the minds of suppliers of essential goods and services, he said.

Chand says that the new requirement of advance approval and other tweaks in regulations aim to ensure that expenses align with the corporate debtor's operational status and safeguard stakeholders' interests, he said. It also leaves scope for an RP and the CoC to work out a practical approach in meeting the CIRP cost.

Rawat of Shardul Amarchand Mangaldas added that IBBI can always hold the RP responsible and take disciplinary steps if he is found to have abused the mandate of keeping the corporate debtor as a going concern. But the provision that creates uncertainty about the payments for service providers affects their continued engagement during the debt resolution process, he said.